Do banks have an obligation to investigate when they pay out under a bank guarantee?

A bank guarantee is a much-used form of a security right. These are real rights that provide security for a claim, such as pledge and mortgage, in international trade. The court recently ruled on when a bank should pay out a bank guarantee. Should the bank itself investigate whether a contracting party is justified in invoking the bank guarantee? Dutch contract lawyer Marco Guit explains.

Bank guarantee as security for compliance by contractor

The facts in this matter are as follows. A contractor entered into a major contracting agreement with a client. To provide additional security for compliance with the agreement by the contractor, the ING bank issued two bank guarantees for the contractor. The text of the guarantee includes the clause that the bank will pay out an amount of no more than $711,200 at the first notice in writing by the client that the contractor is in default.

Was invoking the bank guarantee by the client fraudulent?

At a certain time the client invoked the bank guarantee due to alleged default by the contractor. The contractor subsequently requested the bank not to pay out, because this was allegedly a fraudulent or arbitrary invocation of the guarantees by the client. The bank rejected this request. To prevent payment as yet, the contractor levied a prejudgment attachment on the bank to recover the money.

Strict application by the bank of guarantee terms and conditions

In the subsequent proceedings between the contractor and the bank, the issue is whether the bank has to pay out under the bank guarantees or not. The court finds, first of all, that in view of the nature and function of bank guarantees in the daily course of business, the bank has to strictly apply the terms and conditions in the guarantee. The linguistic interpretation of the wording of the bank guarantee is therefore of vital importance. In particular in this case, where both parties are professionals and the bank guarantee was issued in connection to a business transaction.

Abstract bank guarantee: pay first, talk later

In this case, the bank committed itself to pay out at the client’s first request, stating that the contractor was in default. This bank guarantee can be called an abstract bank guarantee. A feature of such a guarantee is that the bank is in principle obliged to pay out, without addressing the question of whether the contractor was indeed in default. This principle (“pay first, talk later”) precludes the contactor from stopping the payment. However, there is an exception to this if the client demonstrably acted fraudulently or arbitrarily in invoking the bank guarantee.

Limited obligation to investigate by the bank after warning

The court points out the contractor warned the bank, with ample reasoning, that there was no default in this case. Legal precedence shows that the bank is obliged to investigate if such a warning is issued. However, the scope of such an obligation to investigate is limited, which means there can only be a minor investigation to determine if the claim is manifestly fraudulent or arbitrary. In this case, according to the court, this does not apply. The bank is therefore obliged to pay out under the bank guarantees.

Lawyer to draw up a bank guarantee

In this case there was an abstract bank guarantee. But it is of course possible to further define the terms and conditions in a bank guarantee to ensure that this is not invoked arbitrarily. As is shown by this ruling, a bank has to pay out if the terms and conditions are complied with, without asking any more questions. The law firm of AMS Lawyers has ample experience in drawing up contracts including guarantees, to ensure that (payment) obligations are in fact complied with. For more information, please contact our office.